Mercury Editor ALISTAIR LANGFORD-WILSON lifts the lid on how the fraudulent transfers were structured.
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Stealing $176 million can't be easy, especially when it has to be done on the sly over a period of years.
Little wonder, then, that the crooks behind the Trio Capital fraud chose to disguise their larceny using an investment instrument that is both complicated and obscure.
Because when it comes to keeping dirty secrets hidden, layers of obfuscation and complication are highly effective.
The tool they chose is called a deferred purchase agreement, and if obfuscation and complication was their aim, it certainly ticked all those boxes and then some.
But how exactly did this tool of larceny work?
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Deferred purchase agreements (DPAs) are contracts under which the investor puts money in upfront but does not receive the purchased asset until a later date (called the "completion date").
How much the investor actually gets back on that date is calculated using certain performance criteria, which are also specified in the contract.
Typically, those calculations take into account the value of the purchased asset at the defined completion date, as well as the performance over time of an unrelated asset or instrument, which is usually a stock market index or another stock.
In the jargon of DPAs, the asset being purchased is called the delivery asset, while the unrelated performance-based asset is called the underlying asset.
If that sounds convoluted, the key principles can be fairly easily illustrated with an example that uses two things most people are familiar with: beer and property prices.
Here we have an investor, Colin, who is partial to beer and generally tends to buy in bulk for the discount.
As it happens, Colin has just loaded up with a six-month supply when he has a stroke of luck: he wins $1000 on the pokies.
Colin could use the money to load up on even more beer right away.
He knows that beer is around $50 a carton, so he could buy 20 cartons and add them to his existing supply.
But since he doesn't need the beer right away, Colin decides he would be better off investing the $1000 for six months.
That way, when his current supply of beer runs out, he hopes to have more than $1000 to replenish his stocks.
Colin could put his money into the bank but the interest is a pittance - and a taxable pittance at that.
He could invest in stocks, but again, the proceeds may be taxable and with stocks, there is always some short-term risk.
Colin likes the way the Wollongong property market is booming and reckons it offers the best prospect for short-term growth.
But the overheads of buying and selling property make it impractical to invest in that market directly over such a short period.
Instead, Colin enters into a deferred purchase agreement where the value of his investment can benefit from the booming property market - but his reward is still measured in beer.
The DPA achieves this by adjusting the value of his initial $1000 investment based on the performance of the Wollongong property market, as measured by the change in the median price of an apartment in the CBD over the six months.
If that price goes up, Colin's investment will grow and he will have more money for beer.
If it goes down, his investment will shrink - but since when did property prices go down?
How much beer Colin actually gets will depend on the price of beer at that point (the delivery asset), as well as the change in the median price of an apartment in the Wollongong CBD (the underlying asset).
Assuming the median value of an apartment rises by 15 per cent over the six months, Colin's initial investment of $1000 will be worth $1150.
The other party to the contract would then need to "pay" Colin by delivering to him $1150 worth of beer, based on its retail price at the end of the contract.
(And of course, behind the scenes, there will need to be a whole financial structure in place to support the deal.)
If beer is selling for $55 a slab by then, he will receive 23 cartons of beer.
Even though beer has gone up by 10 per cent over the six months, from $50 to $55, Colin is still better off because the Wollongong property market has risen by even more.
Although this example is, of course, absurd, it does serve to illustrate the three essential components of a DPA, which are:
- The value of the initial investment.
- The value of the target investment (the delivery asset) at a specified future date. In Colin's case, this is the beer.
- The performance of an unrelated asset (the underlying asset) measured over a defined period of time. In Colin's case, this is the median price of an apartment in Wollongong.
It also illustrates two reasons that investors may be attracted to DPAs, despite their complexity:
First, they allow investors to benefit from the performance of the underlying asset (in this case, the property market) without investing directly in it.
In Colin's case, for instance, it wasn't practical to invest in the property market by buying an apartment and selling it only six months later.
And second, in certain circumstances, a DPA may give the investor tax benefits where the investment is paid out in assets (in this case, beer) as opposed to cash.
As Colin realised, had he invested in stocks or a savings account, any gains might have been taxed - but as was paid in beer, he hopes to avoid that.
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That's how a basic DPA works - but what about the Trio DPAs?
The Trio DPAs contained several critical points of difference to the way DPAs are usually structured.
The first and most important characteristic that distinguished Trio's DPAs from those marketed by more reputable investment vendors was the nature of the underlying assets.
In a normal DPA, the underlying asset would be something whose value is determined independently of the parties contracted to the DPA.
Typically, stock market indexes are used.
In Trio's case, though, the underlying "assets" were obscure "investment funds" in secretive jurisdictions like the British Virgin Islands.
And they were funds set up either by those actually involved in the scam: some were created by Shawn Richard, others may have been created by his alleged controller Jack Flader.
As would later transpire, these funds were in fact worthless, but in the meantime, since they had control of the funds, Richard and/or Flader could declare their value to be whatever they liked.
Which is exactly what they did.
Amazingly, no-one seemed to notice.
The DPAs were structured as contracts between Absolute Alpha (also known as Astarra Asset Management, which was the investment manager for Astarra Strategic Fund), and an offshore holding company, EMA, which Richard had set up himself, installing his old school chum, Marc Boudreau, as its sole officer.
Under these DPAs, the delivery assets (the things that AAM was ultimately buying), were in fact units in its own fund, Astarra Strategic.
The number of ASF units it would receive depended on the value of an underlying asset - and it was these underlying assets that held the key, because in each case, these were either the Exploration Fund or one of its equally dodgy siblings.
And, as we have seen, the value of those funds could never be ascertained independently or reliably.
That's because they were registered in places such as the British Virgin Islands, where companies are not required to file financial reports or reveal the identities of their owners, directors and shareholders.
Put simply, those funds were worth whatever Richard and/or Flader declared them to be worth.
Just why no-one spotted this at the time is a question that can't be answered, except to say that apparently, no-one was looking.
The Trio DPAs, however, had one other feature that was very odd and which certainly should have been picked up if the contracts had been properly reviewed by anyone with a working knowledge of how DPAs work.
That is, the formula they used for calculating how many ASF units AAM would receive was not only based on fraudulent underlying assets, it was also, in mathematical terms, absolute gibberish.
In our earlier example, how much beer Colin eventually gets depends on how apartment values in Wollongong change over the six months.
This use of a performance-based measure is a standard feature of DPAs: they all have it.
But the Trio DPAs contain no time-based values at all.
Instead, they merely calculate the proportion of the investment that is being cashed out, multiply that by the net asset value of the underlying asset, and divide the answer by the price of an ASF unit.
The idiocy of this can be easily exposed by plugging in some arbitrary values for the underlying asset and the price of an ASF unit.
Let's use $100 for the underlying asset, and $2 for an ASF unit. (The specific values don't matter, so long as they are the same in both examples.)
Our first investor, Bob, puts in $100. Our second investor, Beryl, puts in $1,000,000.
Bob and Beryl both invest at the same time, and they both cash out 100 per cent of their investment on the same day.
Now let's see how this works out.
For Bob:
The proportion of the investment being cashed out is: 100/100 =1
Multiplied by the value of the underlying investment: 1 x $100 = $100
Divided by the value of an ASF unit: $100/$2 = $50
For Beryl:
The proportion of the investment being cashed out is: 1,000,000/1,000,000 = 1
Multiplied by the value of the underlying investment: 1 x $100 = $100
Divided by the value of an ASF unit: $100/$2 = $50
For Colin:
We can also test the calculation using Colin's example, again using arbitrary values for the median price of an apartment (say, $500,000) and the value of a carton of beer ($55) on the completion date:
The proportion of the investment being cashed out is: 1000/1000 =1
Multiplied by the value of the underlying investment: 1 x $500,000 = $500,000
Divided by the value of a carton of beer: $500,000/$55 = 9090
So in six months, Colin would turn an investment of $1000 into 9090 cartons of beer.
Which would be a good bit of business for him, but clearly makes no sense at all.
Footnote
In preparation for this article, the Mercury showed the Trio DPA formula and our analysis of it to five people with academic, financial or legal expertise in the relevant field.
One agreed with our conclusions, the other four said they were simply unable to make any sense of the Trio DPA at all.
We have made available a digital copy of an actual DPA, between Absolute Alpha and EMA, and invite readers to analyse it themselves.
You can let us know if you agree or disagree with our findings by emailing Cydonee Mardon, cmardon@fairfaxmedia.